Deck 16: Working Capital Policy and Short-term Financing

Question 1

The rate of return on fixed assets is normally assumed to be ____ the rate of return on current assets (especially cash and marketable securities).

A) less than
B) greater than
C) equal to
D) none of the above

Answer 1

B

Question 2

The ____ shows the time interval over which additional non-spontaneous sources of working capital financing must be obtained to carry out the firm's activities.

A) inventory conversion period
B) cash conversion cycle
C) payables deferral period
D) receivables conversion period

Answer 2

B

Question 3

When the level of working capital is increased, all of the following are expected to occur except

A) expected profitability decreases
B) expected profitability increases
C) risk decreases
D) none of the above

Answer 3

B

Question 4

Lenders normally feel that the relative risk associated with short-term debt is ____ the risk associated with long-term debt.

A) lower than
B) equal to
C) higher than
D) none of the above

Question 5

Which of the following working capital financing policies subjects the firm to the greatest risk?

A) financing fluctuating current assets with long-term debt
B) financing permanent current assets with long-term debt
C) financing permanent current assets with short-term debt
D) financing fluctuating current assets with short-term debt

Question 6

The length of the operating cycle is equal to the length of the

A) inventory conversion period
B) receivables conversion period
C) cash conversion period
D) a plus b

Question 7

Borrowers (e.g., business firms) feel that there is more risk associated with short-term debt (as compared with long-term debt) because of the

A) uncertainty arising from interest rate fluctuations
B) risk of being unable to refund the debt
C) relatively high cost of short-term debt
D) a and b

Question 8

Under a conservative approach to working capital management, a firm tends to hold a relatively ____ proportion of its total assets in the form of current assets.

A) small
B) constant
C) stable
D) large

Question 9

The relationship between the maturity of debt and its associated cost (interest rate) is referred to as the

A) term structure of interest rates
B) investment opportunity curve
C) risk-return tradeoff function
D) a and b

Question 10

Net working capital represents:

A) the amount of current assets financed by noncurrent sources of funds.
B) the difference between current assets and long-term liabilities
C) the difference between current assets and fixed assets
D) a and b

Question 11

Which of the following factors does not directly affect the firm's level of investment in working capital?

A) the firm's inventory and credit policies
B) the age of the firm's plant and equipment
C) the firm's sales level
D) the length of the firm's operating cycle

Question 12

All other things being equal, a policy of holding a relatively ____ proportion of the firm's total assets in the form of current assets will tend to result in a ____ risk of the firm encountering financial difficulties.

A) large, higher
B) small, higher
C) constant, higher
D) constant, lower

Question 13

Of the accounts listed, the account(s) that is (are) NOT part of a firm's working capital is:

A) plant and equipment
B) marketable securities
C) cash
D) a and c

Question 14

Which of the following factors affect the firm's level of investment in working capital?

A) the length of the firm's operating cycle
B) the firm's sales level
C) the firm's inventory and credit policies
D) all of the above

Question 15

The length of the operating cycle for a firm is equal to the length of the

A) payables deferral period
B) cash conversion cycle
C) receivables conversion period
D) a plus b

Question 16

Historically, the yield curve has generally been ____, which indicates that long-term interest rates usually have been ____ short-term interest rates.

A) upward sloping, lower than
B) downward sloping, higher than
C) upward sloping, higher than
D) level, about equal to

Question 17

With the matching approach to meeting the financing needs of the firm, fixed and permanent current assets are financed with

A) long-term debt
B) short-term debt
C) equity funds
D) a and c

Question 18

All other things being equal, a policy of holding a relatively ____ proportion of the firm's total assets in the form of current assets will tend to result in a ____ expected profitability or rate of return on the total assets of the firm.

A) large, higher
B) small, higher
C) constant, higher
D) constant, lower

Question 19

All other things being equal, a policy of financing its assets with a relatively ____ proportion of short-term debt will tend to result in ____ expected after-tax earnings for the firm.

A) large, lower
B) constant, higher
C) constant, lower
D) large, higher

Question 20

All other things being equal, a policy of financing its assets with a relatively ____ proportion of short-term debt will tend to ____ the variability (or risk) of the after-tax earnings of the firm.

A) large, decrease
B) small, increase
C) constant, lower
D) large, increase

Question 21

The firm's inventory conversion period (measured in days) is equal to its average inventory divided by its ____.

A) cost of sales
B) sales
C) cost of sales/365
D) none of the above

Question 22

The relationship between the maturity of debt and its associated cost (interest rate) is referred to as

A) term structure of interest rates
B) risk-return tradeoff function
C) seniority structure of interest rates
D) a and c

Question 23

Which of the following assets (if any) are not part of a firm's working capital investment?

A) cash
B) accounts receivable
C) inventory
D) none of the above

Question 24

If a firm uses only short-term debt to finance the fluctuating level of current assets, the firm is said to be using the ____ approach to asset financing.

A) aggressive
B) moderate
C) matching
D) conservative

Question 25

The optimal level of working capital investment is the level that is expected to

A) maximize return on total assets
B) maximize earnings per share
C) maximize shareholder wealth
D) minimize interest expenses

Question 26

The size of a firm's investment in current assets is a function of all of the following factors except

A) sales level
B) inventory policies
C) credit policies
D) stockholders equity

Question 27

The aggressive approach to the financing of a firm's current assets uses a ____ proportion of short-term debt and a ____ proportion of long-term debt.

A) low, high
B) relatively high, relatively low
C) high interest, low interest
D) none of the above

Question 28

Net working capital is defined as:

A) total current assets
B) current assets minus current liabilities
C) total assets minus total liabilities
D) current assets plus current liabilities

Question 29

A firm's net working capital position is a widely used measure of its ____.

A) leverage
B) profitability
C) risk
D) none of the above

Question 30

The ____ assets are those that are affected by the seasonal or cyclical nature of company sales.

A) current
B) permanent current
C) fluctuating current
D) none of the above

Question 31

The ____ is the optimal working capital investment and financing policy.

A) aggressive policy
B) moderate policy
C) conservative policy
D) none of the above

Question 32

A firm's operating cycle is equal to its ____.

A) inventory conversion period plus receivables conversion period
B) cash conversion cycle minus payables deferral period
C) a and b
D) none of the above

Question 33

A firm's cash conversion cycle is equal to its operating cycle minus its ____.

A) inventory conversion period
B) receivables conversion period
C) payables deferral period
D) none of the above

Question 34

An anticipated need for short-term borrowed funds is best shown in

A) an operating budget
B) a capital budget
C) a production budget
D) a cash budget

Question 35

Many ____ contain provisions requiring firms to maintain a minimum net working capital provision.

A) loan agreements with commercial banks
B) bond indentures
C) a and b
D) none of the above

Question 36

Basically the overall working capital policy decision involves a ____ of alternative policies.

A) profit-risk tradeoff
B) financial choice
C) risk decision
D) none of the above

Question 37

The firm's receivables conversion period (measured in days) is equal to its accounts receivable divided by its ____.

A) annual credit sales/365
B) annual credit sales
C) annual sales/365
D) none of the above

Question 38

The operating cycle begins with the ____ and ends with the ____.

A) purchase of resources, selling of the product on credit
B) payment for purchases, liquidation of receivables
C) purchases of resources, receipt of cash
D) payment for purchases, receipt of cash

Question 39

Computerized financial planning models may be classified as any of the following except:

A) deterministic
B) optimistic
C) probabilistic
D) none of the above

Question 40

The size and nature of a firm's investment in current assets is a function of a number of different factors including all of the following except

A) how efficient the firm manages its fixed assets
B) the length of the operating cycle
C) the sales level
D) credit policies

Question 41

Gates Industries balance sheet and income statement for the year ending December 31, 1978 are as follows:

*Note: Average inventories also equal $12.0 (million).
Determine the length of the firm's cash conversion cycle.

A) 102.2 days
B) 29.2 days
C) 39.6 days
D) none of the above/cannot be computed

Question 42

Last year Bizmart had credit sales of $32 million and a net profit margin of 8%. If Bizmart had accounts receivable of $4.5 million, what was the length of the receivables conversion period?

A) 51.3 days
B) 56.3 days
C) 54.9 days
D) 47.2 days

Question 43

Tefft Industries has an average inventory of $170,000, sells on terms of 2/10, net 30, and its cost of sales is $540,000. What is Tefft's inventory conversion period?

A) 85 days
B) 115 days
C) 105 days
D) cannot be determined from the data given

Question 44

Commercial paper is:

A) long-term with maturities greater than one year.
B) short-term with maturities under six months.
C) short-term with maturities that do not exceed nine months.
D) long-term with maturities of greater than five years.

Question 45

Renfro Industries balance sheet for December 31, 20x3 is as follows:
What is Renfro's net working capital at the end of 20x3?

A) -$8 million
B) $36 million
C) $92 million
D) $172 million

Question 46

Cryo-vac expects sales to increase 20% next year from the current level of $5,000,000. The firm has current assets of $1,000,000 and fixed assets of $1,500,000. Cryo-vac has current liabilities of $750,000 of which $300,000 are in notes payable. What additional financing will Cryo-vac need to support the expected sales increase if its profit margin is 8% and the firm expects to pay out $200,000 in dividends? An increase in net fixed assets of $300,000 will be required.

A) $130,000
B) $ 70,000
C) Surplus of $70,000
D) $270,000

Question 47

Linear Technology had sales (all on credit) of $36 million and a gross profit margin of 30% last year. If Linear Technology's inventory averaged $3.9 million, and its accounts receivable were $5.0 million, what was the length of its operating cycle?

A) 90.2 days
B) 128.9 days
C) 111.9 days
D) 107.2 days

Question 48

Runners Ink, Inc. had sales last year of $700,000 and 35 percent of its sales are for cash, with the remainder buying on terms of net 30 days. If the receivables conversion period is actually 38 days, what is Runners Ink's accounts receivable?

A) $72,877
B) $25,507
C) $47,370
D) none of the above

Question 49

Great Skot expects to have cash receipts in June of $532,160. Skot's cash disbursements in June are $581,720, including an interest payment on a bond issue of $32,000. If Skot wishes to maintain a cash balance of $40,000, how much will Skot have to borrow if it started the month with a cash balance of $52,000?

A) Surplus of $2,440. Will not have to borrow
B) Surplus of $34,440. Will not have to borrow
C) $5,560
D) $37,560

Question 50

Crystal Oil has $9 million in accounts payable, $1.8 in salaries and taxes payable, and $10.4 in other current liabilities. If Crystal Oil had a cost of sales of $54 million and selling, general, and administrative expense of $18 million, what is the length of its payables deferral period?

A) 107.47 days
B) 73.02 days
C) 54.75 days
D) 45.63 days

Question 51

What is the length of the cash conversion cycle for a firm with annual sales (all cash) of $280,000, an inventory conversion period of 35 days, and a payables deferral period of 25 days.

A) 0 days
B) 25 days
C) 10 days
D) none of the above

Question 52

If a firm shows a profit on the quarterly income statement, then

A) there will be no need for additional financing
B) the firm may need additional financing
C) the firm will increase its cash balance
D) all the above may be correct

Question 53

Sherwood Packing had sales of $3.2 million and a gross profit margin of 35% last year. If Sherwood's inventory averaged $0.4 million last year, what was the length of the inventory conversion period?

A) 130.4 days
B) 70.2 days
C) 195.5 days
D) 45.6 days

Question 54

Cisco Systems wishes to analyze the joint impact of its working capital investment and financing policies on shareholder return. The company has $24 million in fixed assets. Cisco wishes to maintain a debt ratio of 40%. The company's tax rate is also 40%. The following information was developed for the two policies under consideration (dollars in millions):
For the aggressive approach, Cisco's ROE is ____ and for the conservative approach the ROE is ____.

A) 4.18%, 3.77%
B) 11.62%, 10.48%
C) 6.97%, 6.29%
D) none of the above are correct

Question 55

Simmons Industries is considering two alternative working capital investment and financing policies. Policy A requires the firm to keep its current assets at 60% of forecasted sales and to finance 75% of its debt requirements with long-term debt (and 25% with short-term debt). Policy B, on the other hand, requires the firm to keep current assets at 40% of forecasted sales and to finance 50% of its debt requirements with long-term debt (and 50% with short-term debt). Forecasted sales for next year are $20 million. Earnings before interest and taxes are projected to be 20% of sales. The firm's corporate income tax rate is 40%. Its fixed assets total $10 million. The firm desires to maintain its existing capital structure that consists of 50% debt (both long-term and short-term) and 50% equity. Interest rates on short- and long-term debt are 8% and 10% respectively. Determine the expected rate of return on equity next year for Simmons Industries under each of the working capital policies.

A) 26.9%, 30.4%
B) 21%, 26.7%
C) 8.1%, 9.1%
D) 16.1%, 21.3%

Question 56

Laserscope Inc. is trying to determine the best combination of short-term and long-term debt to employ in financing its assets. Laserscope will have $16 million in current assets and $20 million in fixed assets next year and expects operating income (EBIT) to be $4.1 million. The company's tax rate is 40% and its debt ratio is 50%. The firm's debt will be financed by one of the following policies:
What is the return on shareholder's equity under each policy?

A) aggressive = 12.70% & conservative = 12.22%
B) aggressive = 8.47% & conservative = 8.14%
C) aggressive = 4.23% & conservative = 4.07%
D) aggressive = 7.67% & conservative = 8.81%

Question 57

What is the inventory conversion period for O'Brian's if it has sales of $320,000, an average inventory of $5,333, and a cash conversion cycle of 20 days? Assume that the cost of sales is 55 percent of sales.

A) 6 days
B) 11 days
C) 13.5 days
D) 15 days

Question 58

If Swatch's inventory conversion period is 45 days, its payables deferral period is 35 days, and its receivables conversion period is 50 days, then its cash conversion cycle must be ____ days.

A) 60
B) 90
C) 30
D) cannot be determined from information given

Question 59

Barnes Company has highly seasonal sales and financing requirements. Barnes has made the following projections of its asset needs and net additions to retained earnings over the next year (in $ million).
Net worth (equity) at the beginning of the year is $50 million. The company does not plan to sell any new equity during the coming year. Assume that Barnes follows a matching approach to finance its assets, i.e., long-term debt and equity are used to finance fixed and permanent current assets and short-term debt is used to finance fluctuating current assets. Determine the amount of long-term and short-term debt respectively outstanding at the end of the third quarter ($ million).

A) $39; $2
B) $48; $0
C) $41; $7
D) none of the above/cannot be determined

Question 60

Laserscope has an inventory conversion period of 45 days, a receivables conversion period of 42 days, and a payables deferral period of 51 days. What is the length of its cash conversion cycle?

A) 54 days
B) 36 days
C) 48 days
D) can determine with more information

Question 61

What are accrued expenses and how are they handled as unsecured short-term credit?

Question 62

Negotiated short-term credit sources are all of the following EXCEPT:

A) commerical paper
B) inventory loans
C) trade credit
D) bank credit

Question 63

Explain how a firm uses commercial paper as a short-term financing source and explain the disadvantage of using this form of financing.

Question 64

Firm's can meet its financing needs by using a matching approach for financing. What is the matching approach?

Question 65

Name some factors that affect the firm's investment decision to invest in current assets.

Question 66

What is financial forecasting?

Question 67

Factoring accounts receivable is done:

A) on a default basis
B) on a consignment basis
C) on an interest only basis
D) on a non-recourse basis

Question 68

Working capital policy involves day-to-day decisions that determine all of the following EXCEPT:

A) firm's level of long-term assets.
B) proportions of short-term and long-term debt used to finance assets.
C) level of each type of current asset.
D) specific sourcers and mix of short-term liabilities the firm should employ.

Question 69

A firm's working capital position is important from an internal and external standpoint. Which of the following apply:

A) It measures a firm's risk.
B) Provisions for a minimum working capital position are often included in restrictive covenants.
C) A firm's policy often affects its ability to obtain debt.
D) A working capital position determines its level of common stock sales.

Question 70

When factoring accounts receivables, the factor is the:

A) negotiated accounts receivable account.
B) the percent deduction in payment to the firm.
C) the financial institution that buys the accounts receivable.
D) the method of determining how much money is lent to the firm.

Question 71

A firm's working capital position is important since::

A) it is a measure of risk.
B) it is a measure of efficiency.
C) it is much more in demand due to its scarcity.
D) it reflects the amount of short-term liabilities that the firm must consider.

Question 72

When pledging accounts receivables, which of the following statements is/are correct?
I) Pledging requires permission of the SEC.
II) In pledging accounts receivables, the firm loses title to the receivables and they are no longer listed on the balance sheet.

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 73

What are the classifications for short-term lenders and how do they differ?

Question 74

Sources of debt financing are classified according to their:

A) Maturities
B) Interest paid
C) Par
D) Yield

Question 75

Explain trade credit.

Question 76

In examining the term structure of interest rates, the interest rates of ______________ have exceeded short-term rates.

A) Commercial paper
B) Notes payable
C) Corporate bonds
D) Marketable securities

Question 77

In considering factoring accounts receivable, which of the following statements is/are correct?
I) Maturity factoring occurs when the firm receives payment at the normal collection or due date of the factored accounts.
II) Advance factoring occurs when the firm receives payment in prior to the normal collection or due date of the factored accounts.

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 78

Fluctuating current assets are those assets that are affected by:

A) the consumer's demand for the product
B) the seasonal nature of the company
C) management preferences
D) IRS regulations

Question 79

Efficient current assets management refers to the firm's ability to economize on which of the following?
I) Inventory
II) Marketable securities

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Question 80

Why is working capital so important to a firm's continued profitability?